Federal Reserve Credit declined $32.1bn last week to $1.978 TN. Fed Credit
has declined $269bn y-t-d, although it expanded $1.089 TN over the past 52
weeks (122%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this
past week (ended 8/5) jumped another $17.0bn to a record $2.810 TN. "Custody
holdings" have been expanding at a 19.6% rate y-t-d, and were up $414bn over
the past year, or 17.3%.

Total Commercial Paper outstanding increased $10.7bn to $1.076 TN. CP has
declined $605bn y-t-d (60% annualized) and $649bn over the past year (38%).
Asset-backed CP declined $3.0bn to $435bn, with a 52-wk drop of $295bn (40%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's
Alex Tanzi - were up $97bn y-o-y to a record $7.089 TN. Reserves have increased
$324bn year-to-date.

Global Credit Market Watch:

August 3 - Bloomberg (Anna Rascouet): "A gauge of financial-market stress
dropped to the lowest level in more than two years... The TED spread, the difference
between what banks and the Treasury pay to borrow for three months, narrowed
to 29.6 bps... The measure has declined 434 bps since peaking in October last
year..."

August 4 - Bloomberg (Caroline Hyde): "Corporate bond sales surged to an all-time
high of $1.1 trillion in Europe, beating the previous record set for the whole
of 2007... Investors have been lured by the best returns since at least 1998..."

August 6 - Bloomberg (Zijing Wu and Michael Patterson): "The biggest five-month
rally in emerging-market debt since 1996 has cut the ranks of 'distressed'
borrowers in developing nations by more than half. ...The yield on bonds sold
by Argentina, Georgia, Pakistan and Ukraine dropped to less than 1,000 basis
points over U.S. Treasuries in the past three weeks... That leaves only Belize,
Ecuador and Venezuela among the 37 developing nations tracked by JPMorgan with
yield spreads above 1,000 bps..."

August 7 - Bloomberg (Christine Richard): "Ambac Financial Group Inc., the
second-largest bond insurer, posted a net loss for the second quarter of $2.4
billion after increasing its projections for claims on bonds backed by home-equity
loans."

August 5 - Bloomberg (Alan Purkiss): "The global financial crisis has blown
a hole in the 'efficient markets' theory on which modern economics and modern
finance have been based, said Richard Thaler, a professor of economics and
behavioral science at the University of Chicago. Writing in the Financial Times,
he said the theory assumes that everyone in the economy behaves rationally,
which is like leaving friction out of account when doing physics. It consists
of two assertions: that asset prices are right, in the sense that they fully
reflect available information and thus provide accurate signals for allocation
resources; and that market prices are impossible to predict, Thaler said."

Government Finance Bubble Watch:

August 6 - Bloomberg (Jennifer Ryan): "The Bank of England increased its bond
purchase program by 50 billion pounds ($84bn), saying the U.K.'s economic recession
is deeper than policy makers expected. The nine-member Monetary Policy Committee,
led by Governor Mervyn King, kept the key interest rate at 0.5% and said it
will increase its purchase program to 175 billion pounds."

August 6 - Bloomberg (Matthew Brown and Frances Robinson): "Otmar Issing,
former chief economist of the European Central Bank, said inflation will pick
up as soon as the financial crisis has passed unless governments and central
banks remove economic stimulus measures promptly. 'Politicians and industry
might scream' when the measures are withdrawn, 'but this should not be an argument
for central banks and fiscal policies,' Issing said... The exit 'has to happen
at a time when unemployment is still high or even still rising, because of
the lagged effect of the crisis on labor markets. As we have seen the strongest
expansionary policies, fiscal as well as monetary, in the history of the world,
I think it is rather straightforward that as soon as the crisis is behind us,
inflationary pressures will emerge unless policies change course in a timely
manner,' Issing said."

August 4 - Bloomberg (Jody Shenn): "The U.S. government is likely to decide
within 18 months that Fannie Mae and Freddie Mac need to be wound down and
replaced with a similar entity that would support U.S. housing, Moody's...
said. The government-chartered mortgage-finance companies, which were seized
by regulators in September 2008 and since have used $85.7 billion of their
capital lifelines, face mounting losses that will mean 'it could take a decade
or longer' before they are able to emerge from U.S. control as 'viable standalone
entities...' The increasing losses that will be caused in part by government
efforts to use... Fannie Mae and Freddie Mac... as tools to stem the housing
slump... 'This is not bad news for Fannie Mae and Freddie Mac bondholders as
the U.S. government has become entwined with these companies and the creation
of a new entity to support housing finance likely means the orderly conclusion
of Fannie Mae and Freddie Mac,' Brian L. Harris, Craig A. Emrick and Robert
Young, Moody's analysts, wrote..."

August 6 - Dow Jones: "The government's 'Cash for Clunkers' program sent the
auto industry's annualized U.S. sales in the past two weeks to double what
has been seen in the first half of 2009, said... Edmunds.com. It estimated
the recent rate annually at 19.6 million. That compares with the under 10-million
rate the industry had in the first half of this year."

August 5 - Wall Street Journal (Liz Rappaport and Meena Thiruvengadam): "The
Treasury... said it will borrow less in the third quarter than it had previously
expected, in part because banks repaid billions of dollars of government aid
under the Troubled Asset Relief Program. The Treasury said it plans to borrow
an estimated $406 billion in the quarter, $109 billion less than it had estimated."

August 4 - Wall Street Journal (Ruth Simon): "A report card...by the Treasury
Department showed wide variations in how quickly mortgage companies are helping
financially troubled borrowers under the Obama administration's foreclosure-prevention
plan. So far, more than 400,000 borrowers have been offered help. More than
235,000 borrowers, or roughly 9% of those eligible for the program and at least
60 days past due, have begun trial mortgage modifications, the first step to
getting a loan reworked."

August 4 - Bloomberg (Paul Abelsky): "Russia's 'unsustainable' budget deficit
in the next three years is a 'major threat to economic stability' and won't
spur economic growth, Troika Dialog said. 'Such fiscal policy leads straight
down the path to deadlock,' Moscow-based economists Evgeny Gavrilenkov and
Anton Stroutchenevski...said... The government last week approved a plan to
run a deficit of 7.5% of gross domestic product next year... This year's shortfall,
the country's first in a decade, may reach as much as 9.3%..."

Currency Watch:

August 7 - Bloomberg (Laura Cochrane): "Investor demand for emerging-market
bonds is driving the cost of insuring against debt defaults below industrialized
governments for the first time. Credit-default swap prices from Turkey to Indonesia
are falling as bonds rise... As the U.S. and U.K. borrow record amounts to
fund bank bailouts and stimulus, Brazil, Russia, India and China have $3 trillion
in reserves, up 19% from January 2008 and now 43% of the worldwide total..."

The dollar index rallied 0.8% this week to 78.97. For the week on the upside,
the Brazilian real increased 2.5%, the Mexican peso 1.9%, the New Zealand dollar
1.7%, the Swedish krona 0.3%, and the South Korean won 0.3%. On the downside,
the Japanese yen declined 2.9%, the South African rand 2.8%, the Swiss franc
1.3%, the Euro 0.6%, and the Canadian dollar 0.5%.

Commodities Watch:

August 7 - Bloomberg (Jana Randow and Nicholas Larkin): "European central
banks agreed to a third five-year cap on gold sales and said planned disposals
by the International Monetary Fund could be done within the accord. The European
Central Bank and 18 other banks agreed to sell no more than a combined 400
metric tons of the metal a year through September 2014. That's less than the
annual cap of 500 tons in the current agreement..."

August 6 - Bloomberg (Claire Leow): "U.S. proposals to place curbs on commodities
trading will drive business overseas, particularly to Asia, said Jim Rogers,
chairman of Rogers Holdings. 'It is remarkable because America is shooting
itself in the foot again... It's going to drive the business away and the rest
of the world is going to welcome it with open arms.'"

August 6 - Bloomberg (Yi Tian): "Sugar jumped to a 28-year high in New York
as low monsoon rainfall in India threatens to limit cane yields and excess
precipitation delayed harvesting in Brazil, prolonging a global production
deficit."

August 5 - Bloomberg: "Shanghai will take steps to cool the city's real-estate
market as housing prices in China's financial capital are 'too high,' Mayor
Han Zheng said. The city government will increase the supply of land for property
development and speed up construction of affordable housing... Han, 55, said...
Record bank lending in China drove average prices for new homes 6.3 percent
higher in June in 36 large and medium-sized Chinese cities... 'The government
should do something to effectively control the speed of growth of the real
estate market... The housing price in Shanghai is already too high. We must
prevent excessive inflation of home prices in this market.'"

August 3 - Bloomberg: "China's manufacturing expanded for a fourth month in
July as stimulus spending stoked domestic demand... The CLSA China Purchasing
Managers' Index rose to a one- year high of 52.8..."

August 7 - Bloomberg (Chris Cooper): "Japan Airlines Corp., Asia's largest
airline by sales, posted the biggest quarterly loss in at least six years...
Japan Air had a loss of 99 billion yen ($1 billion) in the three months ended
June 30..."

Asia Bubble Watch:

August 7 - Bloomberg (Aloysius Unditu): "Indonesia's central bank, which has
cut interest rates nine times since December, said managing inflation will
be a 'challenge' for policy makers next year."

Latin America Watch:

August 4 - Dow Jones: "Brazil's foreign currency reserves reached a new record
in July... Brazil's foreign reserves totaled $211.87 billion at the end of
July, up from $208.4 billion at the end of June."

August 4 - Bloomberg (Steven Bodzin and Daniel Cancel): "Venezuelan President
Hugo Chavez said he may nationalize two coffee companies after taking temporary
control of their processing plants yesterday and vowed to keep seizing monopolies
as he works to construct a socialist economy. 'We've intervened in these big
companies," Chavez said... 'Now we are conducting a study to expropriate them.
They will become property of the nation.'"

Unbalanced Global Economy Watch:

August 5 - Bloomberg (Svenja O'Donnell): "U.K. service industries from law
firms to insurers expanded the most since 2008 in July, adding to evidence
the economy may be shaking off the recession."

August 7 - Bloomberg (Jana Randow): "German exports increased the most in
almost three years in June... Sales abroad... surged 7% from May..."

August 6 - Bloomberg (Christian Vits): "German factory orders posted their
biggest increase in two years in June, the latest sign that Europe's largest
economy is emerging from recession. Orders, adjusted for seasonal swings and
inflation, jumped 4.5% from May..."

August 6 - Bloomberg (Jacob Greber): "Australian employers unexpectedly added
workers in July... The number of people employed rose 32,200..."

August 4 - Bloomberg (Jacob Greber): "Australian house prices rose in the
three months through June for the first time in five quarters ... An index
measuring the weighted average of prices for established houses in the eight
capital cities climbed 4.2% from the first quarter..."

Bursting Bubble Economy Watch:

August 7 - Bloomberg (Andy Fixmer): "The biggest U.S. television networks
are posting declines of 15% or more in advertising commitments for the prime-time
season starting next month, based on results at CBS and NBC."

August 4 - Wall Street Journal (Lynn Cowan): "Last year's meltdown in financial
markets isn't the primary force behind corporate cuts in retirement plans.
While pensions certainly were affected by the rout in stock prices, many corporate
executives had been eager to put an end to traditional retirement plans prior
to 2008... About 31% of Fortune 1,000 companies have frozen their pensions
now, up from 27% at the same point in 2008..."

Central Banker Watch:

August 5 - Wall Street Journal (George Melloan): "Federal Reserve Chairman
Ben Bernanke assured readers of this page... that he has the tools to prevent
the huge reserves he's pumped into the banks from generating an inflation that
would abort an economic recovery. But does the Fed have the guts to use those
tools? Will it risk censure from Congress and the Obama administration if it
tightens money at the crucial juncture when inflationary omens accompany a
reviving economy? Mr. Bernanke signaled the probable choice by writing that
'economic conditions are not likely to warrant tighter monetary policy for
an extended period.' The Fed's past record of judging when and how to use its
tools for regulating the money supply is not impressive, particularly in times
of economic distress... The Fed's difficulties in getting money policy right
stretch back to its creation in 1913."

August 5 - Bloomberg: "China's central bank reaffirmed today the 'moderately
loose' monetary policy... Policy makers will fine-tune the approach as needed,
the People's Bank of China said... New lending tripled to more than $1 trillion
in the first half of 2009 from a year earlier... The Shanghai Composite Index
has climbed 88% this year."

August 7 - Bloomberg (Alex Nicholson and Paul Abelsky): "Russia's central
bank said it reduced its main interest rates by a 'cautious' quarter of a percentage
point... The bank has cut the rates five times since April 24."

August 6 - Bloomberg (Radoslav Tomek): "The Czech central bank cut its key
interest rate a quarter-point to a record low.... Policy makers trimmed the
two-week repurchase rate to 1.25% from 1.5% at their meeting..."

Real Estate Bust Watch:

August 5 - Bloomberg (Alan Bjerga): "Farmland prices, which advanced for 21
years, couldn't escape the worst plunge in real estate since the Great Depression.
The value of all land and buildings on farms averaged $2,100 an acre at the
start of 2009, down 3.2% from a year earlier, the first decline since 1987..."

GSE Watch:

August 7 - Bloomberg (Jana Randow): "Fannie Mae, the mortgage-finance company
taken over by the government, asked the U.S. Treasury for a $10.7 billion capital
investment as an eighth straight quarterly loss drove its net worth below zero
once again. A second-quarter net loss of $14.8 billion... pushed the company
to request money for the third time from a $200 billion government lifeline...
Today's results bring the company's cumulative losses over the last two years
to $101.6 billion and will bring its total draw on the Treasury to $44.9 billion
since April."

August 3 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac's 'serious'
delinquencies rose 6.8% in May as the government retooled its anti-foreclosure
programs... The serious delinquency rate rose to 4.14% from 3.87% the previous
month."

California Watch:

August 3 - Associated Press: "When California college students return to campus
this fall, they'll find crowded classrooms, less access to faculty and counselors,
fewer campus services and more difficulty getting classes they need to graduate
-- all while paying higher fees. The state's financial crisis is battering
its world-renowned system of higher education, reducing college opportunities
for residents and threatening California's economic recovery."

August 4 - Bloomberg (Michael B. Marois): "California must reduce its prison
population by 44,000 inmates over the next two years to ease overcrowding,
a panel of three federal judges... ruled... There are about 167,000 adult inmates
in California prisons."

Speculator Watch:

August 5 - Bloomberg (Michael McDonald): "Massachusetts will cut investments
in hedge funds after its public pension plan lost a record 24% on all assets
in the fiscal year ended June 30."

Crude Liquidity Watch:

August 3 - Bloomberg (Zainab Fattah): "Dubai house prices halved from a year
ago, almost reaching 2007 levels... Home prices in the desert sheikhdom dropped
48% from a year ago, sliding 9% during the second quarter to an average of
949 dirhams ($258) per square-foot (0.09 square meters)."

The Stock Market and Monetary Disorder

I'll restate my thesis as concisely as I can (not my strong suit): The deeply
maladjusted U.S. "Bubble" economy requires $2.5 Trillion or so of net new Credit
creation to stem systemic (Credit and economic Bubbles) implosion. Only "government" (Treasury,
agency debt, and GSE MBS) debt can, today, fill the gigantic void created with
the bursting of the Wall Street/mortgage finance Bubble. The private sector
Credit system is severely impaired, and there is as well the reality that the
market largely lost trust (loss of "moneyness") in Wall Street obligations
(private-label MBS, CDOs, ABS, auction-rate securities, etc.). The $2.0 Trillion
of U.S. "government" Credit creation coupled with the Trillion-plus expansion
of Federal Reserve Credit over the past year has stabilized U.S. financial
and economic systems.

The synchronized global expansion of government deficits, state obligations,
and central bank Credit amounts to an historic government finance Bubble. Markets
have thus far embraced the surge of debt issuance. This U.S. and global reflation
will have decidedly different characteristics when contrasted to previous Fed
and Wall Street-induced reflations.

First off all, the most robust inflationary biases are today domiciled in
China, Asia and the emerging markets generally. The debased dollar has provided
China and the "developing" world Credit systems unprecedented capacity to inflate
(expand Credit/financial claims without fear of spurring a run on their currencies).
Asian and emerging markets are outperforming, exacerbating speculative inflows.
Things that the "developing" world need (energy/commodities) and want (gold,
silver, sugar, etc.) should demonstrate increasingly strong inflationary pressures.
Their overflow of dollars provides them, for now, the power to buy whatever
they desire.

Here at home, the post-Wall Street Bubble financial landscape ensures the
old days of the Fed slashing rates and almost instantaneously stoking mortgage
Credit, home price inflation and consumption have run their course. Accordingly,
the unfolding reflation will be of a different variety than those of the past
- and, importantly, largely bypass U.S. housing. This sets the stage for a
lackluster recovery in consumption and economic revival generally. Household
sector headwinds will likely be exacerbated by higher-than-expected inflation
(especially in energy and globally-traded commodities), higher taxes and rising
interest rates.

There is a confluence of factors that expose the market to an upside surprised
in yields. The bond market has been overly sanguine, emboldened by the prospect
of the Bernanke Fed maintaining ultra-loose monetary policy indefinitely. Bond
bulls have been further comforted by the deep structural issues overhanging
both the U.S. financial system and economy. However, massive government Credit
creation has, for now, put systemic issues on hold. Especially in Asia, unfettered
Credit expansion creates the backdrop for a surprisingly speedy economic upsurge.
The weak dollar plays a major reflationary role globally, while also raising
the prospect for inflationary pressures here at home. Massive issuance, global
economic resurgence, heightened inflation and a weak currency are offering
increasingly tough competition to the bullish "forever loose policy" view.

Meanwhile, fixed income must gaze at the feverish equities market with disbelief
- and rising trepidation. The bond market discerns incessant economic impairment,
a historic debt overhang, 9.4% unemployment, and begrudging recovery. An intoxicated
stock market ganders something altogether different, with the Morgan Stanley
Retail Index up 61% y-t-d, the Morgan Stanley High Tech Index up 47%, the Morgan
Stanley Cyclical Index up 52%, and the Broker/Dealers up 45%. The bond market
has been content to laugh off the silly equities game. The chuckles may have
ended today.

My secular bearish thesis rests upon a major assumption: The U.S. economy
is sustained by $2.5 Trillion (or so) of new Credit. Only this amount will
stem a downward spiral of asset prices, Credit, incomes, corporate cash flows
and government finances. On the other hand, if forthcoming, the $2.5 Trillion
of additional - chiefly government-directed and non-productive - Credit will
foment problematic Monetary Disorder. In simplest terms, another bout of Credit
inflation leads further down the path of unhinged market prices, destabilizing
speculation, and unwieldy flows of finance.

The stock market has become illustrative of what we might experience in the
way of Monetary Disorder. Speculation has returned with a vengeance, galloping
blindly ahead of fledgling little greenish shoots. Those of the bullish persuasion
contend that the marketplace is, as it should, simply discounting a rosy future.
I would counter that problematic market dynamics have taken over, with prices
increasingly disconnected from reality. In short, the market is in the midst
of one major short squeeze.

There are myriad risks associated with the government's unprecedented market
interventions. Likely not well appreciated, policymaker actions have forced
the destabilizing unwind of huge positions created to hedge against systemic
risk (as well as to profit from bearish bets). This reversal of various bear
positions has created enormous buying power, especially in the securities of
companies (and sectors) most exposed to the Credit downturn. The reversal of
bets in the Credit default swap (and bond) market has certainly played a role.
Surging junk bond and stock prices have fed one another, as the highly leveraged
and vulnerable companies provide phenomenal market returns. The markets are
today throwing "money" at the weak and leveraged.

The resulting outperformance of fundamentally weak companies spurred short
covering more generally, creating a dynamic whereby heavily shorted stocks
became about the best performing sector in the equities market. This dynamic
put significant pressure on so-called market neutral strategies that have proliferated
over the past few years. The strategy of attempting to own the good companies
and short bad ones is faltering, likely causing a flow out of these strategies
- and a self-reinforcing unwind of positions. The "bad" stock soar and the "good" ones
languish.

There's nothing like a short squeeze panic to get the markets' speculative
juices flowing. Many will say all's just fine and dandy - let the fun and games
continue! My retort is that the stock market is indicative of the current dysfunctional
financial backdrop. At the end of the day, the financial system must be capable
of effectively allocating finance and real resources throughout the economy.
I would argue that this is not possible for a system that congenitally misprices
risk and distorts financial asset prices. Today's stock market will inherently
finance mainly speculative Bubbles and fragility. And the core systemic problem,
the maladjusted "Bubble economy," well, the financial backdrop only worsens
the situation.

I have great confidence that government finance Bubble dynamics ensure ongoing
distortions in the markets' pricing of risk and, as well, a continued misallocation
of resources (financial and real). And it is increasingly clear that the stock
market is embroiled in this problematic dynamic. But that is a dilemma for
another day, as surging stocks fan optimism and risk embracement - not to mention
forcing many into the stock market with both nostrils plugged. And speculative
equities and Credit markets will spur increased economic output in the short-run.

Everything has been extraordinary; the boom, the bust, policymaker interventions,
and now the bear market rally. I wish I could see some mechanism in the works
that will help kick our system's addiction to easy Credit and commence the
inevitable process of economic adjustment and restructuring. Instead, I see
confirmation everywhere that policy and market dynamics are working in concert
to sustain the existing financial and economic structure. I have huge doubts
it will work and no doubt about the risks of failure.